“If I can’t find a reindeer, I’ll make one instead”! – Dr.Seuss, How The Grinch Stole Christmas

Last week in The Case Against Bitcoin I examined some of the flaws with Bitcoin that may prevent it from becoming a mainstream currency. I received some very intelligent comments and had a series of thoughtful conversations with many Bitcoin advocates who promoted Bitcoin’s value and efficacy as a currency. While I believe there is value in peer to peer financial transaction systems, I remain, however, unconvinced that Bitcoin will be a widely used digital currency of the future.

Here’s why:

Greater Adoption Should Mean Lower, Not Higher Prices

If Bitcoin’s advantages lie in using a crypto currency system one would think that the cost of using it would decrease over time, not increase exponentially. The argument that more people will be using crypto currencies and more convenience and security features will be added to the Bitcoin system to justify higher Bitcoin prices runs counter to market principles. With competition, prices should drop.

The price of cars did not go up exponentially as more roads and bridges were built, motels and restaurants were added to the sides of the highways and more people used automobiles as a mode of transportation. Competition ensured that Fords would not be the only cars on the road and that prices for cars would remain affordable. Similarly, there will be additional competing crypto currencies, many superior to Bitcoin, that will keep a lid on the price of Bitcoin.

The peer to peer aspect of Bitcoin is superior to traditional electronic payment systems. Unfortunately, in order to access the system increasingly higher prices have to be paid to use it. This is a self defeating proposition. The Bitcoin system is substantially the same one of three months ago, but today Bitcoins cost four times more. Technology advances should make use cheaper not more expensive. To encourage adoption, prices need to be lower not higher. For example, Tesla will not increase the price of its cars ten fold as it adds more charging stations around the country to increase the utility of its battery powered vehicles. If it did they would see their sales plummet. If the price per Bitcoin remains high, competing lower priced crypto currencies will become more attractive and displace Bitcoin;especially since there are no barriers to entry in the crypto currency market.

If the value of Bitcoin is in the features of the system, not the value of the Bitcoin itself, the logical solution would be to charge to use the Bitcoin system. This is not possible with Bitcoin as no one owns the system, therefore the price of Bitcoins must necessarily rise as demand increases as more people wish to use it. This dynamic however, contains the seeds of the destruction of the price of Bitcoin as higher Bitcoin prices will inhibit widespread use and competing, less expensive crypto currencies will emerge that will undercut the price of Bitcoin. Also competing centralized commodity backed currencies will emerge that will allow payments to be made using proprietary currencies.

The high Bitcoin valuation is what is attracting people to it, not its utility as a currency. That increasing valuation, is also leading people not to use Bitcoins in transactions and rather to hoard the coins in the hope that they may be worth more in the future.

A viable currency can not be so expensive that its price deters buyers from buying it and sellers from using it for fear it might go higher.

Bitcoin – A Peer to- Peer Currency

Artificial Mining Scarcity

The computer mining of Bitcoins, the trading component of the Bitcoin system, is an artificial construct. Mining for real commodities like silver or drilling for oil has real costs and real returns. Silver is needed to power the electronics (without silver Bitcoin doesn’t work!) and solar industries and oil is needed, among many things, to heat millions of homes, for gasoline to power millions of cars and to create countless plastic products. Thus, the costs of mining for silver and oil are justified in that they lead to the extraction of silver and oil and the prices of these commodities can be valued based on their need and demand. In contrast, the mining costs of Bitcoins can only be justified if demand can be created for the Bitcoins themselves.

The underlying value of the Bitcoin itself is based on a Bitcoin computer mining game that wastes electricity to solve math problems that don’t need to be solved, and therefore is not a meaningful measure of value. Bitcoin mining is in effect, the solving of riddles for riddles’ sake. How can a value be placed on Bitcoins if they have no intrinsic value or unique properties? If Bitcoin’s value is in its use as a crypto currency, why wouldn’t any crypto currency do?

Once you own Bitcoins you must necessarily believe that they are valuable and try and convince others that they are as well. Its hard to ascribe value to a currency that is not backed by anything. The common rejoinder is that government currencies are not backed by anything either and that Bitcoin has superior properties (ease of transfer,lower costs of transfer,anonymity) and therefore Bitcoin’s $1200 per coin price is justified. This is the repugnant ‘lesser of two evils’ argument – “Bitcoin isn’t backed by anything but the dollar isn’t either”.

While the dollar is not backed by anything other than the “full faith and credit” of the issuer, legal tender laws ensure its use.

In contrast, an attractive feature of Bitcoin is its use is voluntary and people are free to believe in it and ascribe value to it. The flip side, however, is people are also free NOT to believe in it and ascribe value to it. Bitcoin can not be propped up by force of law. It’s value is based on collective belief of value and usefulness. If collective faith is lost in Bitcoin, its value diminishes or vanishes.

Legal tender laws may be repugnant, but so is unbacked money.

The artificial construct of Bitcoin computer mining is at the heart of the lack of intrinsic value argument. The Bitcoin creators did not find a gold mine, they created one. Indeed, no one would have gone looking for Bitcoins ten years ago because they did not exist. The “invented” characteristic of Bitcoins is what will prevent them from retaining value. Basing a currency’s value on a non productive arbitrary activity (actually wasteful) like mining for Bitcoins, is as inane as basing a currency on how many times a group of people can run around the block-no matter how limited the number of coins you issue as a result of that pointless endeavor.

Mining of natural resources has a purpose and the extraction of them is limited by nature not by self serving computer design.

The concept of arbitrarily creating scarcity to create the perception of value by inventing a computer game that requires people to waste electricity to solve math problems to extract Bitcoins seems like a pretty easy concept to replicate. It also seems like a concept that if repeated would highlight why value should not be ascribed to such arbitrary and unproductive activity.

Current Price/Valuation

As of this writing, the price of Bitcoin is over $1000. The recent vertical price move of Bitcoin over the past month or so is based on a simple premise – more people want Bitcoins because the price is going up, not because they have any use for them. Bitcoin’s stratospheric price level is not based on any comparable benchmarks and will eventually collapse as competing and lower priced digital currencies gain traction and provide some basis of price comparison. Anything that rises as fast and as high as Bitcoin has recently, inevitably crashes. Bitcoin may, however, continue to soar along with the entire crypto currency sector.

Bitcoin is being valued as if it is a unique invincible currency. That perception and reality will not last. Bitcoiners cite the ability of Bitcoin holders to send payment directly to an individual in China or to take their Bitcoins cross border without raising the suspicion of customs officials as justification for its lofty valuation. While these are useful features, the vast majority of people will never have use for cross border transactions or the evasion of capital controls.

Bitcoiners also justify the value of Bitcoin by noting that it is outside of the system and therefore not subject to manipulation. Any item with a price that is traded can be manipulated. There are already plans for a Bitcoin ETF. ETFs provide Wall Street with any number of potential manipulative devices, including lending, short selling and hypothecation. If someone or some entity wished to manipulate the price of Bitcoin it could be done.

The price of Bitcoin is clearly in a bubble as its price has not been driven by any identifiable fundamentals or meaningful comparables. A stable Bitcoin price is extremely important in determining its future as a viable currency. A crash in Bitcoin’s price would make it further unsuited for use as an everyday currency and damage Bitcoin’s long term ability to continue as a viable currency. If that happens Bitcoin will have failed the market test. If, however, despite the flaws pointed out here, Bitcoin’s price stabilizes and its adoption as a currency increases, it will have passed the market test. My bet is that it won’t but markets are smarter than me or any of us.

*even if security prevents the stolen Bitcoins from ever being used, hacker/thieves can shut down the Bitcoin system by stealing large amounts of Bitcoins to intentionally disrupt the 21 million limited supply. Government confiscation of Bitcoin can achieve the same result. The 21 million Bitcoin limit is a dual edged sword which means there can be no further discovery of Bitcoin even if most of them have gone missing. The inability to create more Bitcoins in the event that most of them have been stolen or lost would render the currency useless. The 21 million limit is a built in kill switch.

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mite be a problem with the analogy with the categories…cars are a good…bitcoin is a money…and also, bitcoin’s price in USD rising doesn’t make it more expensive necessarily (ie. because it’s price can go up in USD, but it’s purchasing power can go up the same..therefore it’s no worse off in terms of purchasing power)

Smaulgld

good point – the car is probably an inartful analogy. You are also correct that the price rising doesn’t make it more expensive. The reason it gets confusing is that bitcoin is touted for its superior payment system, while at the same time the price of bitcoin and its rise is constantly mentioned as a positive attribute of the system.
I am struggling with the value of the coin and the value of the payment system

Gold marketcap is 7-8 trillion usd from what i see. Not sure how much of that is for jewelry. A heavy majority of that marketcap i think is for it’s function as a financial asset . For Bitcoin marketcap is 13b usd. I think bitcoin has been replacing gold somewhat in the financial asset function so far (gold flat to down in the last year)

Smaulgld

That appears to be somewhat the case although the valuation of bitcoin is based on a false hood- Bitcoin has more value because it is digital and can’t be taken away. Also bitcoin can be easily replicated in the form of other digital crypto currencies.

I am not as much a fan of gold as silver because a large amount of gold’s value is monetary. Silver however is a much smaller market of about only $20 billion!!! And silver has real industrial uses. I know many people who have cashed in some bitcoin and bought silver.

Richard Ellicott

recently the gold price plummeted and it also has only been on the way down, when it crashed earlier this year it took silver with it, admittedly the price for the first time ever diverged a bit

but not much, so I’d say Silver and Gold are pretty much the same

gold is more attractive for jewellery and also a better conductor,

like this guy i would not be too surprised if some investors where looking for an alternative to what had been basically 5-6 years of gold prices steadily rising

i would be careful with x is useful “reasons” though, it’s more this flock behaviour imo

When someone creates a quantum computer that breaks encryption – you will find your fiat money bank account will also be empty and so worthless… The internet will be 100% insecure.

If the world still exists, once the superpowers decrypt all the files their spies have collected from their ‘enemies’ – launch codes, account numbers, security info of all kinds… I think your bitcoins will be the least of your worries.

And as bitcoin (like all currency) is actually only secured on people willingness to part with their possessions and labour in return for it – a collapse of currency will just cancel all the debts (expectation of future work) it is secured on… we will still have all the ‘stuff’ and know who it belongs to – and we will still have our labour to sell/exchange for whatever comes next…

Smaulgld

This is true re encryption (and the world) to a point. Security will evolve beyond encryption. Will bitcoin?
Paul thanks for the thoughtful and intelligent comments

Richard Ellicott

lol… censored

Richard Ellicott

u suck

Sean McKeown

Supply and demand: the price of Bitcoin is rising because the supply is growing slower than the demand is. The supply is limited to those that presently exist +150 coins per hour, while the demand is growing both because of the speculative effect but also because more retail adoption of Bitcoin is providing actual currency interaction in parts of the world that have adopted Bitcoin. Those places happen to not be in the US, so you’re just seeing speculative price booming, but there is a credible argument that part of the price boom is due to a) recent legal clarifications that show Bitcoin to be outside of US regulatory authority, in some key ways, and b) growth in the areas where bitcoin can be spent (thanks largely to BitPay this past year, speeding adoption up considerably faster than rate of currency base growth).

So, yes, market forces are at work here. Some speculators want to ride a bubble, some speculators want to evade a coming economic crash, but the growth in demand to use the currency is presently outpacing growth in the monetary base of the currency. Adoption in its use is coming largely from the utility of the currency, such as low transfer prices from point to point; you can send a million dollars of bitcoins for a few cents, while the same transaction at a Western Union costs you tens of thousands of dollars. The attractor to Bitcoin presently is the challenge to monopolized hardware pipelines that are extracting rents; Bitcoin’s hardware pipeline is the internet, which extracts no rents.

Smaulgld

all good point, thanks

Here is a question that I just formulated- If a thief steals a lot of bitcoins I hear that he would have a hard time using them. BUT what if the point of stealing them is to disrupt the system in two ways
-destroy confidence in the system; and

-actually take down the system by removing millions of bitcoins from the system making the remaining ones presumably more scare and more valuable BUT target to further theft

Sean McKeown

Both plausible, and makes you wonder who the thieves are – if it’s a hackerspace-supported community, presumably the anti-authoritarians are in favor of stability of the Bitcoin currency base, which makes the hackers in this case pro-authoritarians such as the CIA or other aspects of the US government seeking to overcome the Bitcoin challenge to the US dollar’s central bank.

And destruction of the wealth of others in order to enjoy greater wealth themselves is basically the business model of some modern banks. This is, unfortunately, not a Bitcoin-specific issue, but I don’t want to go into the weeds and sound like someone with Tourettes who doesn’t like Goldman Sachs or J.P. Morgan Chase.

Smaulgld

BItcoin has plenty of enemies and it also has plenty of vunerabilities. That $1000 price per bitcoin is a bullseye on its back. After all unbacked currency are based on confidence and anything to shake that confidence will be tried. Hence making up a computer game that wastes electricity to create bitcoins won’t withstand the confidence test

Sean McKeown

Understandably so. I look forward to meeting Bitcoin’s children, because a currency backed not by fiat promises of “full faith and credit” or even gold is nowhere near as interesting to me as a future currency backed by computer cycle access. The most important aspect of Bitcoin, to me, is not its price, market capacity, or adoption growth – it’s the growth of a capitalist, for-profit distributed computer networking system creating virtual supercomputer access using micropayments to sell computer cycles. Presently it’s solving useless riddles, but segue it over to something marketable and we have a whole new ballgame.

Its application in new places are fascinating, as is its growth potential. I really wish Bitcoin adoption in Greece could skyrocket, to counter the austerity crisis that is forcing loss of productivity – the factors of production could go to work using this alternative currency system no matter what the ECB says, because Bitcoin is not regulated by the ECB, Bitcoin can potentially find applicability the same way direct barter does in crisis economies like Weimar Germany or modern Greece. Any digital or alternative currency could, but presently the consensus direction to adopting Bitcoin has a snowball effect that grows more market adoption… new digital currencies have to go through the same growth process, which is why you’re focusing on Bitcoin but not addressing Litecoin, which has recently passed the 1:1 coin-to-dollar price within the past month or two.

I think you miss the point entirely (as do most). Bitcoin price is 100% stable, a bit coin is worth (and will remain worth) one bit coin, As long as a currency is freely tradeable it is never ‘expensive’ or ‘cheap’.

The value of a bitcoin (in the current phase) is equivalent to a little bit more than the tech required to create one. Priced in fiat currency that tech is rapidly getting more expensive – priced in bitcoins it is static.

If you hold fiat currency, you can exchange it for existing bitcoins, or you can buy some tech to mine your own – only a fool would go the more expensive route!

If you already held your wealth in bitcoins you would be laughing at the collapse in value of fiat currencies.

Bitcoins going missing will not be a problem for a long time – the system allows them to be divided into 0.00000001 BTC – the smallest thing being a 10nanoBitCoinPiece.

Just as many years ago a man could live on pennies a week, but now needs many thousands – bit coin will go the other way… old prices will seem huge, not tiny.

In the later phase (once mining is complete) all bets are off. Lots of people will have lots of tech that only exists to preserve the value of their holdings (by keeping the system going) – as they take commission (on bitcoin transactions, paid in bitcoins) to pay for running the kit they will probably accumulate all bitcoins in existence – so eventually becoming untradeable and so worthless.

However, being aware of this future, bitcoin will be swapped wholesale/upgraded to allow new mining to occur – simply to preserve the value of investments already made.

Smaulgld

In some respects Bitcoin is a bit of an embarassment. After years of complaining about the lack of sound money, libertarians rally around an invented currency with out any backing whose basis of value is artificial “scarce” bitcoins that can be mined by wasting massive amounts of electricity.

The bitcoins WILL be found its not like real mining where your project
may not yield the “inferred deposits”. As long as you waste enough
electricity the bitcoins will emerge and if the Bitcoin evangelizers can
convince enough people that they are worth something you will get a
return on your investment.

If someone from outer space watched Bitcoin mining they would think the human race had gone mad. If you have to convince people that bitcoin has value, it doesn’t.

No fiat currency is backed by anything more real that peoples willingness to accept it.

If you want a currency backed by something real but can’t afford gold – how about chocolate coins? Prices have just dropped following the christmas boom!

Smaulgld

The reward for the out put of energy should exceed its expenditure.
You make a good point re diamonds-they are mined at great cost soley for their beauty and adornment.
Farming one would think would be a better use of energy as it feeds people.
You point re gold is also well taken as most of gold’s use is for adornment and display-although there are industrial uses for gold and it serves as a monetary metal.
These two types of mining are however superior to bitcoin mining as tangible items are extracted. While the value ascribed to them is subjective there is a history of humans wanting diamonds and gold. Bitcoin on the other hand is a forced demand with no value.
The argument gets weaker when one moves to commodities like silver and oil-these are extracted using energy but have real use value- silver for industry and oil for industry and heating, transportation etc.
Of the two silver could serve as the best money as it has real life value and is also perfectly suited as a monetary metal.
Mining and drilling for oil causes no head shaking moment for a space race that understands that humans need electronics (silver) and to keep warm (oil)
Bitcoin mining would appear as a mere game- a con game at that

‘Mining’ bit coin does have tangible value – it was taking that tangible work, tangible value and labelling it Mining that was very clever (although leading to some misconceptions)

The bit coins created through ‘mining’ are actually a by-product of administering the entire bitcoin model. Providing the bitcoin community with computing resources to run its accounts system, and provide the security of the mass-processing encyrption chain does not come free – so the ‘bitcoin community’ pay for these computing resoruces (and the secutiry the encryption/work provides) with new bit coins.

In return for administering fiat currency, central banks get to print extra money for its own use. In return for administering bitcoin, miners have the opportunity of creating new bitcoins. The difference is that you have no control over the central bank – but bitcon miners (administrators) are controlled by an openly published, 100% predictable set of rules…

I have said I think the bitcoin model, when all have been mined, will be different, but certainly up to that point it is a reasonable, sensible, rational system.

Smaulgld

These are excellent points and highlight the genius of the system.
They only highlight however the concept that if you want to create artificial value you have to create a system that endorses and reinforces that system.
My complaint all along has been why create an artificial scarcity via mathematics and then try to foist it on the world as valuable?

The value is what ever ‘the public’ decide it is – unlike national currencies noone can be forced to accept bitcoins to settle a debt – you decide what labour/property you are willing to trade for bitcurrency.

I think ‘scarcity’ is the wrong word to use if you are looking at this in any detail – you can trade down to a billionth of a bit coin – so there are many, many ‘bitunits’ being created they are just created in huge batches – a bitcoinworth of these tiny units are created at a time. Maybe, like gold, it should be seen as lumpy/unevenly distributed – hard to find a batch at all, but when you do find one, its a huge nugget.

The maths/processing-power/speed of creation link is essential to the trust/securty – its non-negotiable if there is to be a secure currency at all.

Rapid electronic trading has caused all kinds of problems in financial markets – bitcoin avoids any such risk by simply saying however hard you work, however many CPU’s you throw at it, however fast you process, you can still only create bitcoins at the speed set out in the original spec. The velocity of the bitcoin model is set in coins/hour, not coins/MIPS – it scales automatially to the size of the mining force.

However valuable or worthless it is (in itself) its value is a bit above that of fiat currency… Or maybe it *is* a fiat currency – but by fiat of the participants, not of the state? And that’s what has been missed ’till now?

Smaulgld

“The value is what ever ‘the public’ decide it is ” Correct and a lot of that value is all speculation or wishful thinking!

” noone can be forced to accept bitcoins to settle a debt – you decide what labour/property you are willing to trade for bitcurrency.” That is the philosophically attractive part of bitcoin- it is also its weakness-while the fiat nature of current government currencies is not a positive attribute-it is effective.

“The maths/processing-power/speed of creation link is essential to the trust/securty – its non-negotiable if there is to be a secure currency at all” And this can be replicated by other math problems and called “currency”

“bitcoin avoids any such risk by simply saying however hard you work, however many CPU’s you throw at it, however fast you process, you can still only create bitcoins at the speed set out in the original spec”

easily replicated-can create millions of currencies with built in “math based” limits.

“Or maybe it *is* a fiat currency – but by fiat of the participants, not of the state? And that’s what has been missed ’till now?”
I had originally called bitcoin in my first post “fiat currency” that is technically incorrect and I changed it to “thin air” The difference is with fiat currency the government states that the value “is” based on nothing but the force of law. With bitcoin the value is agreed upon, but its based on nothing but a thin air wish for it to have value

Arguing that it could be done a differently seems to be a bit of a diversion from whether it is worth doing.

The government can only say a dollar is worth a dollar or a pound is worth a poud – just as a bitcoin is worth one bitcoin – so it is no worse. On the upside no government is manipulating the value for its own benefit.

Smaulgld

“Arguing that it could be done a differently seems to be a bit of a diversion from whether it is worth doing.” Correct, if you are going to do it, then they way it was done is good. BUT if you are just inventing things that model can be copied and if there are no barriers to entry and people want to believe the value of bit coin, why not believe in ANY coin, Kayne coin, lite coin etc.
Comparing bitcoin to the government currencies is not convincing as we all know the flaw in govt currencies. They make up for it by the force of law. If people stop and think and realize there is no value in bitcoin, it vanishes

William_C_Diaz

Except for the fact that as of 2/26/14, bitcoin has gone into the toilet.

You were wrong.

Have a great day!

Sven

“If someone from outer space watched Bitcoin mining they would think the
human race had gone mad. If you have to convince people that bitcoin has
value, it doesn’t.”

Any other race has probably gone through this phase. It’s part of evolution. How do I know? Because it’s happening.

Of all the criticisms you make, the one I have the hardest time understanding is that the price of bitcoins increases dramatically, unlike (say) cars. I just don’t see why that’s a disadvantage of bitcoin. Consider:

Your business is to make something, say tables. You’ve made a table that you’d like to sell. You would also like to buy a coat. The point of money is to eliminate the requirement for double coincidence of wants. Instead of finding someone who wants a table *and* has an excess coat, you sell the table for money, then use the money to buy the coat (from someone else).

Let’s say you’re using bitcoin as money. In 2012, you “sell” your table for 2 bitcoins. (I don’t know if that number is realistic, but just for the sake of illustration.) You turn around and buy a coat for these same 2 bitcoins. A year later, after bitcoin has become much more expensive, you sell your table for 0.2 bitcoins, and buy a coat for 0.2 bitcoins. How are you worse off the second time compared to the first time?

It’s true that if you *hold* bitcoins, they go up in value (assuming your complaint about bitcoins becoming more expensive takes place during that time). But why is that a bad thing?

Smaulgld

Hi Larry
There is noting “wrong” with prices going dramatically higher or lower as the market dictates-that price action,however is more the attribute of an equity security not a currency.

Currencies only fluctuate wildly if there is something wrong with them (they drop) or something wrong with other currencies (they rise).
One could argue bitcoin is going up (like gold’s rise over the past 13 years) is because there is something wrong with other fiat currencies.

Bitcoin ,however is more speculative than gold and since it is a concept rather than a commodity its hard to benchmark the vale of bitcoin as a currency so it trades like a speculative social media stock.

It can go down just as swiftly as it went up because currently other than perhaps international money transfers, bitcoin isn’t needed to transact day to day. Buying bitcoins to buy pizza or junk on overstock is a political statement not an economic necessity. For that reason the demand for bitcoin is not so much as obtaining bitcoin for use but rather to hold for price gains. But you are not holding anything! Bitcoin’s best properties require use.

On a different note I am not convinced that privacy is best assured by posting every transaction to a public block chain…

LarryRuane

Yes, I agree that the value of bitcoin is fluctuating wildly. I’m asking about something different; I’m trying to understand this statement from your article above: “[I]n order to access the system increasingly higher prices have to be paid to use it.” I just don’t see why that’s a knock against bitcoin. As I tried to say above, who cares how high the price of a bitcoin goes? Suppose sometime in the future one bitcoin exchanges for $1,000,000. If I can exchange a table that I want to sell for (say) 100 uBTC (a uBTC is a micro-bitcoin, which is one millionth of a bitcoin), which is equivalent to $100 in my example, and I can immediately turn around and buy the coat I want for the same 100 uBTC, then why do I care?

Smaulgld

you are correct that when one wishes to transact it matters not what the “exchange rate” is.
The price of bitcoin matters when one holds it longer than the time make a transaction -ie. speculators and those that think it is a store of value.
.
This highlights why the price could be anything and why the high price may come plummeting down as other coins that can do the same thing. True the lower priced coin is not really more attractive for purposes of making a transactions just because you can buy 100 whatevercoin for $100 instead of .10 bitcoin (although there is a psychological advantage) but the lower priced coin IS more attractive if one wants to also buy and hold an additional $100 worth of whatever coin.